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Potential 50% Upside From These Two Retailers

The stock market always looks ahead. That old axiom has never
been more true as investors seek out companies that are slumping
now but poised for better days ahead.

Just look at the stock charts of
Office Depot (NYSE:
ODP
)
,
H&R Block (NYSE:
HRB
)
and
Sandridge Energy (NYSE:
SD
)
. Theirshares have been making an upward move even through
quarterly results remain fairly dismal. Farsighted investors
understand that these companies should be assessed on where they're
headed, not where they've been.

That logic keeps me focused on the retail sector, where current
results are disappointing, but the road ahead -- with just a
moderate reduction in unemployment rates -- could push sector sales
up moderately and profits higher at a robust clip.

Here are some retail names I'm focused on right now...

1. HHGregg (NYSE:
HGG
)
Electronics retailer
Best Buy (NYSE:
BBY
)
enjoyed a nice stretch of less competition when rival Circuit City
went out of business in 2009. Not anymore. Regional chain hhgregg
has begun to expand away from its focus on the Southeastern United
States, beating a path toward the eastern seaboard. After years of
steady growth, sales have now pushed past the $1.5 billion mark,
and hhgregg is starting to mark real gains in terms of inventory
management, supply chainlogistics and purchasing power.

Yet you'll find that results for the all-important 2010 holiday
selling season were pretty sobering. A still-cautious consumer and
an electronics segment that has had a dearth of hot new products
led to tepid fiscal third-quarter (ended December) results.
Although sales rose 30%, they still came in below management's
plan, as same-store sales fell 6%. That spurred a wave of analyst
downgrades and
shares
are now down from $30 last spring to a recent $17.

I'm a big fan of growth stories that hit temporary hiccups and
are suddenly loathed by myopic Wall Street analysts. These are
precisely the times to get involved with stocks like this,
especially in the case of hhgregg, where the slowdown is unlikely
to last past this year.

My optimism stems from an expected eventual rebound in consumer
spending, along with a steady expansion in hhgregg's store base.
The company has boosted its retail outlets by about 40, to a
current 174 stores, a figure that may exceed 200 a year from
now.

Right now, the tougheconomy is masking the benefits of that
expansion. For example, gross margins have slumped roughly 100
basis points from a year ago, equating to roughly $6 million in
lost income, or about $0.16 a share. The company is expected to
boost profits about 20% in thefiscal year that begins in April.
With an
economy
on stronger footing, theprofit growth would have likely been closer
to 30%. I expect margins to rebound in calendar 2012, which could
help this retailer boost profits by at least 20% again, even if the
store expansion cools.

Meanwhile, shares trade for about 13 times projected (March) 2012
profits, roughly half the multiple that hhgregg garnered in the
past few years. If this retailer were running out of growth
opportunities, such a low multiple would make sense. The fact that
shares also trade for about six times projected EBITDA, on an
enterprise value
basis, makes little sense. To my mind, it merely serves as a great
entry point before same-store sales and
profit
margins rebound. Shares could trade back up to 20 times
forwardearnings , representing 50% upside.

2. Casual Male(Nasdaq:
CMRG
)
If you followed
my advice
last July and bought shares of this menswear retailer when it
traded around $3.30, you would have scored a 50% gain by October as
shares moved past $5. Well, you've just gotten a second chance as
shares have since pulled back to around $4.20.

Little changed in the ensuing seven months, except for the fact
that hopes for a consumer-led rebound have been pushed from 2011
into 2012.

Casual Male caters to large men, many of whom struggle to find
suits and other clothes in their sizes at traditional department
stores. The reason to own this name: management has done an
impressive job of controlling costs, which explains why profits in
the
fiscal year
that ended in January likely doubled, even as sales were flat. That
helps set the stage for further profit gains in coming years, even
if sales grow only modestly. Analysts think sales in fiscal
(January) 2012 can rise by 2% to 3%, but per-share profits could
rise nearly 20% to about $0.39.

I'm not putting too much stock in that forecast just yet. Shares
have fallen more than 20% recently, which may indicate that
fourth-quarter results were challenging. If that's the case, then
shares may pull back, presenting an even greater bargain for
long-term investors. If you've got a long-term view, my
back-of-the-envelope math from last summer still applies: If you
assume that sales rebound to 2007 and 2008 levels of about $465
million (from a likely $400 million in the year that just ended),
then the company's newly-lowered cost structure couldyield $30
million in
operating income
, or $0.70 a share. That means shares now trade for about six times
that "normalized profit." A multiple of 10 times profits seems more
appropriate. For patient investors with a one- or two-year time
horizon, you may be looking at 50% upside.

Action to Take -->
As I've noted in the past, the retail sector could show solid
profit gains even on only moderate sales growth. That scenario
looks less likely to play out in 2011 than I had expected, but it
is a real possibility for 2012 and beyond. Investors always look
ahead, so sector shares may well move back into favor this year. As
I mentioned, the two names above look to have about 50% upside.
Other retailers I like include
RadioShack (NYSE:
RSH
)
[see my write-up
here
],
Aeropostale (NYSE:
ARO
)
[
here
], and
Supervalu (NYSE:
SVU
)
[Ryan Furhmann's analysis
here
].

-- David Sterman

P.S. -- There's an interesting way to make money that's getting
a lot of attention lately. In short, a Texas man has figured out
how to collect an extra $3,000 to $6,600 each and every month by
simply owning shares of some of the safest stocks on the planet. If
this sounds like something you're interested in, keep reading…

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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